Well, well, well... very interesting discussion. First of all, you both have been patient and true gentlemen about this game so far. I think it would be great if we can find a way to fight through. I will leave a number of alternatives, I'm going to throw everything at a wall and just see what sticks...
#1 What rufus proposed: Axis retreats to about original Western border and we have Barbarossa with Allied coming in to rejoin. This solution is elegant for its simplicity, but I feel it unfavorably dooms the Axis.
#2 Chuck, did you mean switch places in the game as it is right now, or restart the game with you as the Axis? Probably the latter?
(Or more bizarre choices...)
#3 USA is "permanently" neutral. If USA were never to enter the war, do either of you think the Axis could ring out a victory? Or does the current situation already preclude any hope for the Axis. (We can revise later if Axis tilt the balance heavily in their favor)
#4 We cede all non-French European holdings to the Germans. The Czech cease resistance and allow themselves to be conquered.
#5 We call a temporary armistice. The Axis and Allies agree to a peace treaty, which the Axis will again violate when they have prepared better (I'm not sure this will help though, considering how defense-oriented this game tends to be, and giving the Allies time to maximally-concentrate their defense).
Many of these could be joined together.
#6 I'm going to mention one last option. It's not my favorite, but it was something I have given thought to, and it's not *too* far from a historical possibility. The USSR can enter the war on the same side as the Axis temporarily, assisting the Axis to gain an adequate land foothold, and then we can see how this goes and discuss an Axis (or Soviet) betrayal later on. I think Barbarossa is the main draw of the Russian side, but hopefully that can still happen later.
I'm happy to "engineer" the game diplomacy in order to balance the teams, swinging different nations to different factions to keep a relative balance.
I'm also okay if the series has really no hope and we just want to begin a new game. At least I have learned a lot about this scenario.